The thin-capitalization rules impose a restriction on the deduction of interest expenses in respect of loans provided by foreign lenders / shareholders including entities located in low-tax, no-tax or tax-haven jurisdictions.
The interest deduction restriction applies if the amount of debt exceeds the equity by 3 times i.e. the debt-equity ratio exceeds 3:1. The deduction restriction does not apply to interest paid to resident lenders.
However, the excess interest may be carried forward for deduction in the following 3 tax years (subject to the same interest deduction restriction).
The deductible amount of interest is restricted to the value arrived at after applying the formula below and the fulfillment of several general conditions (see Sec. 6.5.):
I x [3 (C/D)], where:
I = Total amount of interest accrued in the fiscal year;
C = Average annual balance of the book capital calculated by adding the capital balance at the beginning and end of the fiscal year and dividing the result by two; and
D = Average annual balance of all debts of the taxpayer that accrue interest calculated by adding the balance of such debts at the beginning and end of the fiscal year and dividing the result by two.
The interest deduction restriction does not apply to the entities that are members of the financial system regulated by the financial and monetary authority.